Securities Law - Does Rule 10(b)(5) Have An Extraterritorial Effect?

Respondent, National Australia Bank Ltd. (“National”), the largest bank in Australia, has its shares traded on the Australian Stock Exchange and on other foreign securities exchanges but not on any exchange in the United States. National bought the stock of HomeSide and operated it as a subsidiary. HomeSide’s business was to receipt fees for servicing mortgages. These services are a valuable asset and the more valuable it is, is a function of period in which the fees will be paid. HomeSide calculates the present value of the mortgage servicing rights by using a valuation model designed to take the likelihood of prepayment into account. In other words, if mortgages are prepaid, the service fees stop to the extent of such repayment.

From the allegations in the Complaint, it is alleged that National’s Managing Director and Chief Directing Officer plotted the benefits of National but it also alleged that they did not take into account the write-downs necessary because of prepayments.

In July 2001, National wrote down HomeSide’s assets by $450,000 million and then again on September 3, 2001 by another $1.75 billion. The shares dropped in value. These plaintiffs alleged that the executives manipulated HomeSide’s financial models to make the rates of early repayment unrealistically low in order to cause the mortgaging servicing rights to appear more valuable than they actually were. Two Australians purchased ordinary shares in 2000 and 2001 before the write-downs. They sued National and HomeSide in the United States District Court for the Southern District of New York for violations of §10(b) and §20(a) of the Securities Exchange Act of 1934, and Rule 10(b)(5). They sought to represent a class of foreign purchasers of National’s ordinary shares up to the September write-downs.
Plaintiffs, the Australians, according to the Complaint, invested based on false information. The Second Circuit held that the specific language of §30(b) does not show Congressional intent to preclude application of the Exchange Act to transactions regarding stock traded in the United States which are affected outside the United States.

The Supreme Court in an opinion by Justice Scalia stated that there is no affirmative indication in the Exchange Act that §10(b) applies extra-territorially and that “we, therefore, conclude that it does not.”

The Court further stated that it is our view that only transactions of securities listed under domestic exchanges and domestic transactions and other securities to which §10(b) applies. Thus, §10(b) reaches the use of a manipulative or deceptive device or contrivance only in connection with the purchase or sale of a security listed an American stock exchange and the purchase or sale of any such security in the United States.

Justice Stevens, with whom Justice Ginsberg joined, concurred in the judgment.

Justice Stevens stated that he took exception to the statements in the majority opinion that the decision rested on the construction of the statutory text. “I happen to agree with the result the court reaches in this case. But, ‘I respectfully dissent,’ once again from the Court’s continuing campaign to render the private cause of action under Section 10(b) toothless.

Edward X. Clinton, Sr.

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Securities Law - Use of Insider Information

The SEC on October 30, 2010 filed a complaint against Dr. Yves M. Benhamou in the U.S. District Court for the Southern District of New York (10-CV-8266 (DAB)) alleging that Dr. Benhamou engaged in insider trading by providing confidential non-public information to several hedge funds.

According to the Complaint, six healthcare related hedge funds sold about 6,000,000 shares of Human Genome Sciences, Inc. (“HGSI”) and at the time the portfolio manager of the hedge funds possessed material negative non-public information concerning a clinical trial of the drug Albumin Interferon Alfa 2-a (“Albuferon”, a drug to treat ashtma). Benhamou was an advisor to the portfolio manager of the hedge funds. Benhamou, a citizen and resident of France, was one of five members of the Steering Committee overseeing the Albuferon clinical trial.

According to the Complaint, in January 2008, HGSI announced that all patients who had been administered a higher dosage level of Albuferon in its clinical trial would be moved to the lower dosage level because of safety issues with the most recent clinical trial. The Complaint alleges that Benhamou learned this negative material non-public information about the drug as a member of the Clinical Steering committee which had negative implications for commercial potential and that Benhamou passed the negative information to the portfolio manager of the hedge funds before the announcement was made public. When the information became public, the market price of HGSI’s common stock fell about 44%.

The hedge funds sold about 6,000,000 shares of HGSI representing all of its holdings before the announcement and avoided a $30 million loss. The market price of the drug went down 44% after the announcement.

It is alleged that Benhamou communicated this negative information in violation of his duty as a member of the Steering Committee and that the portfolio manager of the hedge funds knew or should have known that Benhamou served on the Drugs Trial’s Steering Committee and owed a duty of confidentiality.

The SEC charged that Benhamou violated § 17(a) of the Securities Act of 1933 by (a) employing a device scheme or artifice due to fraud; (b) obtaining money or property by means of untrue statements of a material fact or omitting a material fact in order to make the statements made in the light of the circumstances under which they were made not misleading, or (c) engaging in a practice or course of business that operated or would operate as a fraud or deceit.

The SEC seeks a permanent injunction enjoining the Defendant from violating (a) § 20(e) and (b) § 21(d)(1) of the Exchange Act and (b) from violating § 17(a) of the Securities Act, and (c) § 10(b)(5) of the Exchange Act. The SEC seeks to have (a) Benhamou disgorge with prejudgment interest all illicit trading profits or losses avoided as a result of the conduct alleged in the Complaint, and (b) ordering the Defendant to pay civil penalties pursuant to Securities Act and the Exchange Act.
According to the Wall Street Journal, the Defendant was also charged criminally and was arrested in New York

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Evidence - The Admissibility of Hearsay Statements By A Party Opponent

HEARSAY: STATEMENTS BY THE AGENT OF A PARTY-OPPONENT

By
Edward X. Clinton, Jr.
The Law Offices of Edward X. Clinton, P.C.
30 North LaSalle Street, Suite 3400
Chicago, IL 60602

Statements by an agent of a party-opponent are under certain circumstances hearsay admissions of the party-opponent.

This article will describe how to introduce or resist the introduction of statements by a party's agent under Rule 801(d)(2)(D) of the Federal Rules of Evidence and will discuss the debate concerning whether the declarant must have knowledge concerning the underlying facts and the exception for statements by government agents. These issues often arise in personal injury and employment litigation.

Some recent cases suggest that it is becoming more difficult to obtain admission of a statement by a party opponent.

To review: Hearsay is an out-of-court statement by the declarant admitted for the truth of the matter asserted. Rule 801(c). Under Rule 801, admissions of a party-opponent are not hearsay. One type of admission by a party opponent is a statement by an agent of the party-opponent. According to Rule 801(d)(2)(D), a statement is not hearsay if it is offered against a party and was made by "the party's agent or servant concerning a matter within the scope of the agency or employment, made during the existence of the relationship." The rationale is that "an agent or servant who speaks on any matter within the scope of his agency or employment during the existence of that relationship, is unlikely to make statements damaging to his principal or employer unless those statements are true." Nekolny v. Painter, 653 F.2d 1164, 1172 (7th Cir. 1981), cert. denied, 455 U.S. 1021 (1982).

I. A Three Part Showing Is Required

To prove that a statement is admissible a party must make a three-part showing. The offering party must demonstrate (1) the existence of an employment or agency relationship "independent of the declarant's statement offered as evidence;" (2) that the statement was "made during the existence of the declarant's `agency or employment" and (3) that the statement concerns a matter within the scope of declarant's employment or agency relationship. Boren v. Sable, 887 F.2d 1032, 1038 (10th Cir. 1989). I will now discuss each requirement in detail.

II. Is The Declarant The Agent or Servant of the Party Opponent?

Under the Rule the proponent must first establish that the declarant is the agent of the party opponent. Whether Rule 801(d)(2)(D) applies depends on the relationship between the declarant and the defendant. Zaken v. Boerer, 964 F.2d 1319 (2d Cir. 1992), cert. denied, 113 S.Ct. 467 (1992). In employment litigation one employee may sue a colleague and attempt to introduce a hearsay declaration by another employee. It is not dispositive that both the declarant and the defendant work for the same employer. Id. at 1323. In Zaken, plaintiff alleged that she was fired by the defendant, the president of a corporation, on the basis of her pregnancy. She sought to introduce the hearsay statement of a company vice president that another employee was fired because she was pregnant. The declaration was admissible because the vice president was directly responsible to the defendant and was therefore the defendant's agent. Id. See also Boren v. Sable, 887 F.2d 1032, 1039 (10th Cir. 1989) (in a personal injury action against a co-employee the court excluded a statement by the shop foreman because he was not the agent of the co-employee). If the foundational requirements are met, it may not even be necessary to identify the declarant. Pappas v. Middle Earth Condominium Ass'n., 963 F.2d 534, 537-38 (2d Cir. 1992) (in slip and fall case the statement by an unidentified employee was admissible to show that the defendant was aware of an icy patch on a walkway).

It is possible for an attorney to be the agent of a party. See United States v. Harris, 914 F.2d 927, 931 (7th Cir. 1990) (defendant's former attorney's statements were admissible but the court noted that "the unique nature of the attorney-client relationship, however, demands that a trial court exercise caution in admitting statements that are the product of this relationship."); United States v. Brandon, 50 F.3d 464, 468 (7th Cir. 1995) (important policies "concerning the effective assistance of the counsel of one's choosing" must also be preserved). In Harris, the court found that the conflict between the attorney-client relationship and the rule was not serious because the former attorney did not represent the defendant at trial.

III. Was the Statement Made During the Existence of The Agency?

Next, the proponent must demonstrate that the statement was made during the existence of the agency or employment relationship. This requirement is straightforward and prevents the admission of statements made after the agency relationship terminated. See Blanchard v. Peoples Bank, 844 F.2d 264, 267 n.7 (5th Cir. 1988) (statement by former employee inadmissible because the employee was not employed by defendant when the statement was made); Corley v. Burger King Corp., 56 F.3d 709, 709 (5th Cir. 1995) (statement by manager of Burger King admissible to show he was acting within scope of employment when he was driving a car involved in an auto accident).

IV. Does The Statement Concern A Matter Within The Scope of The Agency?

The proponent must also demonstrate that the statement concerns a matter within the scope of the agency or employment relationship. The Rule does not require that the declarant "have authority to bind its employer," because few employers will authorize employees to make binding admissions in litigation. Big Apple BMW Inc. v. BMW of North America, Inc., 974 F.2d 1358, 1372 (3d Cir. 1992), cert. denied, 113 S.Ct. 1262 (1993); see also Advisory Committee Note to Rule 801(d)(2)(D); Woodman v. Haemonetics Corp., 51 F.3d 1087, 1094 (1st Cir. 1995) (same).

Courts analyzing this requirement apply a common sense approach to the scope of employment. In Nesbit v. Pepsico, Inc., 994 F.2d 703 (9th Cir. 1993), plaintiffs alleged that they had been terminated because of their age. At trial, plaintiffs introduced a statement by the defendant's senior vice president of personnel that: "We don't want unpromotable fifty-year olds around." Id. at 705. The district court held the statement inadmissible because plaintiffs failed to show that the vice president was acting within the scope of his employment. The Ninth Circuit conceded that the ruling was error, but found the error harmless because "the statement was very general and did not relate in any way, directly or indirectly, to the terminations of Nesbit or Selby." Id. It is readily apparent that a personnel manager's duties include hiring and firing. Thus, the manager's comments were within the scope of employment. See also Woodman v. Haemonetics Corp., 51 F.3d 1087 (1st Cir. 1995) (in ADEA claim, statements by a supervisor that new management wanted to bring in younger employees were admissible because the statements concerned matters within the scope of the supervisor's employment); EEOC v. Watergate At Landmark Condominium, 24 F.3d 635, 640 (4th Cir. 1994) (comments of members of condominium committees concerning age of employee were admissible in ADEA action because the members had input in the decisional process).

Where the declarant has nothing to do with employment decisions, the court will exclude the hearsay statement. In Staheli v. University of Mississippi, 854 F.2d 121 (5th Cir. 1988), the court excluded statements by a colleague of a professor who was denied tenure because the colleague was not involved in the tenure decision. At trial, the plaintiff sought to testify that an accounting professor told him that the university's chancellor was unhappy about an incident involving laboratory animals. The accounting professor's statements were excluded because he had nothing to do with the denial of tenure. The statement had no relationship to the scope of his duties for the school. Id. at 127.

What about the comments of an agent of a subsidiary? Can those statements be held to be admissions of the parent corporation? In Big Apple BMW, the court found that statements by an employee of BMW credit and leasing could be attributed to the parent corporation because the parent dominated the activities of the subsidiary. 974 F.2d at 1373.

V. Exception For Statements By Agents of the Government

The rule does not apply to government employees. United States v. Prevatte, 16 F.3d 767, 778 (7th Cir. 1994). According to the Seventh Circuit, the rationale for this exception is that "no individual can bind the sovereign." Id. at 779. In United States v. Kampiles, 609 F.2d 1233, 1246 (7th Cir. 1979), cert. denied, 446 U.S. 954 (1980), the court explained that "because the agents of the Government are supposedly disinterested in the outcome of a trial and are traditionally unable to bind the sovereign, their statements seem less the product of the adversary process and hence less appropriately described as admissions of a party." In criminal cases, introducing statements of other Government agents (say FBI agents) could prejudice the Government and require the Government to call additional witnesses to rebut the alleged statement.

One commentator has criticized this exception. See Edward J. Imwinkelreid, "Of Evidence and Equal Protection: The Unconstitutionality of Excluding Government Agents' Statements Offered as Vicarious Admissions Against the Prosecution," 71 Minn. L. Rev. 269 (1986). However, there appears to be no effort in the courts or in Congress to abolish the exception.

VI. Recent Caselaw – Statements Are Often Excluded Based on Other Evidentiary Rules.

In Keri v. Board of Trustees of Purdue University, 458 F.3d 620 (7th Cir. 2006), the Seventh Circuit affirmed a grant of summary judgment to Purdue University on Plaintiff’s racial discrimination claims. Plaintiff sought to admit the statements of two professors who had previously complained that “most students were not taught by black faculty.” Neither witness provided testimony on why plaintiff was not retained by the employer. The witnesses simply gave their opinions concerning the racial climate on campus.

The District Court excluded the statements on the ground that neither professor had any decision-making authority in the employment area and that the statements were not within the scope of their agency. Moreover, the statements were improper under Rule 701 which bars a witness from expressing an opinion unless the opinion is based on first-hand knowledge.

Similarly, in Williams v. Pharmacia, 137 F.3d 944 (7th Cir. 1998), the Seventh Circuit held that it was error (in a sex discrimination case) to admit statements of other employees who were also allegedly subjected to discrimination by a particular supervisor. As the court noted, the complaints made by the women did not fall within the scope of their employment. As the Court noted, “they were the subjects of the decisions; they did not make them.” There was no evidence that the declarants had any involvement in the decision to terminate the Plaintiff. See also Hill v. Spiegel, 708 F.2d 233, 237 (6th Cir. 1983).

In Mister v. Northeast Illinois Commuter Rail Road, 571 F.3d 696 (7th Cir. 2009), the Seventh Circuit affirmed a decision excluding statements of a party opponent on Rule 403 grounds, even though it disagreed with the District Court’s analysis.
Mister was a railroad employee who was injured when he slipped and fell. The Defendant’s inspector prepared a report which included a statement that another employee had falled the previous week at the same spot. The District Court excluded the statement because the investigator had no personal knowledge of the events described.

The Seventh Circuit held that there was no requirement that the declarant (the author of the report) have personal knowledge of the events. As the Court noted, the Rule “’simply requires that the statement be made by an individual who is an agent, that the statement be made during the period of the agency, and that the matter be within the subject matter of the agency.’” quoting Young v. James Green Mgmt., Inc., 327 F.3d 616, 621 (7th Cir. 2003). However, the Seventh Circuit held that it “was not improper” to exclude the report because the report appeared to be unreliable and it lacked precise factual statements.

Statements may also be excluded when they would act as improper expert testimony. In Aliotta v. National Railroad Passenger Corp., 315 F.3d 756 (7th Cir. 2003), the plaintiff was killed by a train. The District Court excluded the statements of a risk manager of the defendant, who stated that fast trains can cause vacuums that suck nearby people underneath their wheels. The testimony was excluded on the ground that it was scientific testimony that was unreliable under Daubert and Rule 702, which require the judge to determine if scientific testimony is relevant and reliable.

On appeal the Seventh Circuit agreed that the statements of the risk manager were classic statements by a party opponent within the scope of the agency. The Seventh Circuit held that the statements were properly excluded because they were improper expert or opinion testimony that was not based on the scientific method. As the court concluded, “we see no good reason why unqualified and unreliable scientific knowledge should be exempted from the expert evidence rules simply because the speaker is an employee of a party-opponent.” The holding of Aliotto that a statement that is an admission of a party opponent is not admissible because it is unfounded and unqualified expert testimony is highly significant. In my experience, lay witnesses often attempt to offer opinions that they are not qualified to offer.

VIII. Conclusion

In sum, Rule 801(d)(2)(d) is relatively straightforward and easy to apply to most factual situations. However, a party hoping to introduce a hearsay admission by an agent of a party-opponent should make sure that it can satisfy all three foundational requirements. As I have noted, Rule 801(d)(2)(D) can be of great significance in employment litigation, where employees may comment on a termination, and in personal injury suits arising out of injuries on the jobsite, where employees may witness the accident or corrective measures. Obviously, an employer desiring to protect itself from litigation should caution employees to refrain from commenting on terminations or other adverse employment actions.

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